Institutional Equities

Monetary Policy Committee Meeting Minutes

17 August 2017

We are participating in AsiaMoney’s MPC Highlights Growth Challenges, But Focus Is On Inflation Brokers Poll 2017. We would be The minutes of the Money Policy Committee (MPC) held on 1-2 August 2017 have been released. Dr. pleased if you vote for us as the Ravindra Dholakia, who has been the most dovish, voted for a 50bps cut while Dr. Michael Patra, who is feedback helps us align our equity the most hawkish, voted for a pause. Reserve Bank of (RBI) Governor Dr. Urjit Patel, Dr Chetan research offerings to meet your Ghate, Dr. Pami Dua and RBI Deputy Governor Dr seem to have voted for a 25bps cut on requirements. Click Here the basis of downside risks to growth and soft inflation in the preceding months. Dr. Viral Acharya was of the view that high real rates are justified in the current environment, absent efficient transmission, as Teresa John, CFA attempts to address balance sheet problems with aggressive monetary easing can backfire by Research Analyst (Economist) misallocating investments and fuelling asset price inflation. Governor Dr. Urjit Patel also noted that there [email protected] is some scope for banks to cut lending rates on their existing portfolio. The MPC was non-committal on +91 22 3926 8114 further easing, and it is likely to depend on inflation further undershooting expectations. However, with inflation having bottomed out and expected to rise going forward, we believe the easing cycle has likely come to an end. In our view, the emphasis will now shift to monetary policy transmission through stressed asset resolution and reduction of lending rates on existing loans. While the Marginal Cost of Lending Rate (MCLR) for new loans has been reduced by about 80bps on an average, the weighted average lending rate of banks has been reduced by only 40bps. The RBI has set up an internal working group to study various aspects of the MCLR system with a view to improve transmission, which will submit its report in September 2017. Nevertheless, we believe that further lending rate cuts by banks will largely be dependent on their ability to reduce deposit rates as banks remain focused on protecting their margins. Economy Update Economy Growth is a concern, but the focus remains on inflation: All four members who voted for a 25bps rate cut, Governor Dr. Urjit Patel, Dr Chetan Ghate, Dr. Pami Dua and RBI Deputy Governor Dr. Viral Acharya seem to have done so on the basis of downside risks to growth and soft inflation in the preceding months. Although references to growth slowdown were ample, none of them seemed to suggest aggressive easing to support growth. Dr. Chetan Ghate expressed concern at the slowing rate of capital accumulation. Based on the fact that he expected a negative output gap to sustain in 2QFY18, with inflation within the target range of 4+/-2%, he voted for a 25bps rate cut. He also pointed out that with the US Federal Reserve announcing a gradual tapering of its balance sheet to begin in the near term, some volatility is likely to be imparted on emerging market exchange rates and financial markets which needs to be carefully watched. Dr. Pami Dua noted weakness in momentum for domestic growth and exports, along with a downturn in global inflation gauges. Dr. Viral Acharya highlighted that output gap estimates turned somewhat negative after the last quarter's growth numbers, and together with easing of underlying inflation, and with the RBI’s 12-month ahead inflation forecast (excluding the Seventh Central Pay Commission’s house rent allowance or HRA impact) expected to be within the mandated target, there seems to be some room for monetary policy accommodation. Dr. Urjit Patel noted that Consumer Price Index or CPI inflation excluding food and fuel softened over the past three months, and forward-looking information on demand conditions for 2QFY18 do not suggest much risk of immediate demand pressures. Therefore, with some signs of downside risks on the underlying growth momentum in industry and services, he voted for a 25bps rate cut. Easing cycle has likely come to an end: The MPC was non-committal on further easing, and it is likely to depend on inflation undershooting expectations further. Dr. Viral Acharya was of the view that high real rates are justified in the current environment, absent efficient transmission, as attempts to address balance sheet problems with aggressive monetary easing can backfire by misallocating investments and fuelling asset price inflation. With inflation having bottomed out and expected to rise going forward, we believe the easing cycle has likely come to an end. We expect headline inflation (excluding the HRA impact) to be slightly above 4.5% by 4QFY18. Going forward, we see inflationary pressure from the increase in HRA, upturn in food prices, formalisation effect of GST, increase in rural wages and minimum support price (MSP) for crops and also farm loan waivers. Moreover, interest rates across the developed world are being normalised, and with the US Federal Reserve expected to begin shrinking its balance sheet in the next few months, the room for manoeuver by the RBI is limited Emphasis to shift to transmission and resolution of stressed balanced sheets: Governor Dr. Urjit Patel, pointed out that there is some scope for banks to cut lending rates on their existing portfolio. In our view, the emphasis will now shift to monetary policy transmission through stressed asset resolution and reduction of lending rates on existing loans. While MCLR for new loans has been reduced by about 80bps on an average, the weighted average lending rate of banks has been cut by only 40bps (Exhibit 1). The RBI has set up an internal working group to study various aspects of the MCLR system with a view to improve transmission, which will submit its report in September 2017. Nevertheless, we believe that further lending rate cuts by banks will largely be dependent on their ability to reduce deposit rates as banks remain focused on protecting their margins.

Institutional Equities

Exhibit 1: Weighted average lending rate has not been cut significantly (%) 12.0 11.5 11.0 10.5 10.0 9.5 9.0 8.5

8.0

16

16 17 17

16

16 16 16 16 16 17

16 17

17

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- - -

-

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-

Jul

Apr Oct Apr

Jun Jan

Feb Mar

Sep Aug Nov Dec

May May Weighted average lending rate MCLR Source: or RBI, Nirmal Bang Institutional Equities Research

2 Monetary Policy Committee Meeting Minutes

Institutional Equities

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3 Monetary Policy Committee Meeting Minutes